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Analysis: Indian elections

India’s newly elected government has inherited a dire fiscal situation with little scope to address the economic downturn and reinvigorate reforms. But pressure is high. With 1.1 billion inhabitants, India ranks second only to China among the world’s most populous countries.

Both main blocs, the Congress-led United Progressive Alliance (UPA) and the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) campaigned as pro-reform, and the new administration is expected to adopt a “pro-poor” policy. UPA has won most seats. The victory, however, was narrow.

Good governance at a state level was a key to success. Avinash Vazirani, the manager of the Jupiter India fund, says that parties that have governed well have been rewarded with votes.

“In effect, this has been a great victory for Indian democracy,” he says.

In previous elections, religious and caste allegiances have determined the outcome. This time, the UPA should easily be able to achieve an absolute majority as smaller parties and independents join the winning coalition. Moreover, the absence of the left-wing parties in the support base will mean the UPA will be better able to push through its reform agenda.

The outcome also shows what Indians want: roads, power, affordable housing, health and education, says Vinay Gairola, a fund adviser to the Atlantis India Opportunities fund. He followed the elections closely and, like many fund managers, is positive about the result. The new set-up clears the way for reforms in sectors like pensions, labour, insurance and power, while a weaker BJP should also allay the fears of India’s neighbours.

Mark Williams, an Asia economist at Capital Economics, writes in an Asian Economics Weekly bulletin that a strong government will be better placed to push on with structural reform. But the result will make “little difference” in the short term, he argues.

The election results have taken economists and electorates by surprise. The uncertainty was also reflected in the fact that fund managers have long held high cash positions. Gem and Bric (Brazil, Russia, India and China) fund mangers tended to underweight India.

The perception of India “has been clouded by concerns about the outcome,” says Sam Mahtani, the director of emerging equities at F&C.

Once the results were made public, the Sensex, or Bombay Stock Exchange Sensitive Index, rose by 17%. Trading on the Bombay Stock Exchange even had to be halted for around two hours. The rupee jumped 2% against the dollar in its sharpest one-day rise in a decade.

In a statement, Mahtani writes that the UPA victory should allay many fears. This could be a “game changer” for India and could unlock higher levels of growth for the country in the medium and long term, he says.

With the reduction of political risk, the risk premium for India will come down significantly and the equity market will re-rate, investors like Shelley Kuhn, the manager of the Neptune India fund, predict.
Teera Chanpongsang, the manager of the Fidelity India Focus fund (Sicav), says that a strong mandate for the Congress should lead to a stable government, which increases the likelihood of speedier and more focused economic reforms at a time when India’s fiscal situation is deteriorating.
“Investment-friendly policies expected from the new government should also improve foreign fund inflows and benefit the corporate sector, which has been under pressure from lack of capital availability,” Chanpongsang says.

The new government will face two main challenges, according to Williams. In the short term, the concern is cushioning the downturn. The budget, however, suggests that the various parties’ pledges may amount to little, given fiscal constraints.

The only thing in the new government’s favour, Williams says, is the drop in oil prices in the past year. They will allow it to continue redeploying subsidies to areas where their impact on the real economy is greater.

“This boost will soon fizzle out. Thereafter, the new government’s hands will be tied: it will soon have to consider reducing the budget deficit, which will have a contractive effect on the economy.”

Other factors, such as low infrastructure spending and the state’s role in the economy and banking sector, are still hampering India’s growth and development.

While the immediate focus might be on stability of a new government and its plans to respond to the downturn, over the long run, its willingness to step up the pace of reform is likely to matter more, he says.

According to a Capital Economics estimate, India’s growth, previously predicted to be between 7.5% to 8% this year, may start to slip. Vazirani, however, says a reinvigorated drive for economic reform could see better-than-forecast GDP growth. Currently predicted at 5% to 6% for this year, he expects it to reach as much as 7%.

Unlike in other parts of the world, Indian economic fundamentals are supported principally by domestic demand.

“We see market strength as being quite broad initially as Indian equities are re-rated on an improved political outlook,” Kuhn says. She expects specific sectors, such as banks, insurers, infrastructure plays and potentially the mining sector, to eventually outperform the broader market.

Her Neptune India fund is “well placed” to benefit from these market movements, she says. It is overweight in financials and has “significant” exposure to infrastructure themes. She will add to these core positions over the next few days to take advantage of market strength and sector outperformance as earnings outlooks improve. Meanwhile she plans to trim exposure to the low beta healthcare and consumer staples sectors.

Mahtani agrees that India still looks “attractive and the opportunities for investors are potentially substantial”.

Sukumar Rajah, a sub-adviser on the Franklin India fund (Sicav), says that consumption plays are essential, as household consumption is set to nearly triple in the next 16 years. Domestic consumption constituted 67.8% of India’s GDP growth last year, he says. Key drivers for the Indian economy will be rising income levels coupled with a burgeoning middle class that will keep consumer demand strong, he says.

The amount of investor cash sitting on the sidelines could therefore provide additional support to the market, says Vazirani, as domestic mutual funds and foreign investors have generally been underweight equities.

“[Fund managers] thought there was uncertainty but will be happy to start investing their cash.” He says there is a “huge amount of liquidity” and things were looking “quite positive”.

Infrastructure, energy and the agricultural sector will be the “biggest long term winners”, says Gairola in a statement. Telecommunications, retailing and defence industries are also “likely to benefit from more foreign participation and domestic investment”.

Others, like Rajah, find opportunities in sectors such as healthcare, consumer staples and financial services.

These developments are also laying the foundation for a long-term rally in stock prices. The market got more than it could hope for in the form of steady governance without the crutch of left-wing support.

Sashi Reddy, an investment analyst on First State’s global emerging markets team, says that in the long term, companies with high levels of debt will take the opportunity to raise capital, resulting in a rush of equity issues, particularly in the real estate, infrastructure and commodity sectors.

“We believe the market is running ahead of itself in the short term. We expect to see a considerable amount of momentum-based buying over the next week or so.”


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